Why Most M&A Deals End Up Badly

BlackRock's (NYSE:BK) acquisition of Barclays Global Advisors (NYSE:BCS) for $13.5 billion has left bankers hoping that the slowdown in mergers and acquisitions has now hit a bottom and their bonuses can start going back up again. Advisers like Boston Consulting Group are arguing that now is the time, and companies must move quickly to make acquisitions at rock-bottom valuations.

But despite low prices and the adage that companies always must invest during a downturn, now may not be the time to consider M&A, as opposed to alternatives like investing in organic growth.

My firm, the China Market Research Group, has analyzed hundreds of M&A deals announced over the past two decades, and we've found that the shareholders would have been better off in about 70% of the cases if they'd never set off on the path toward M&As.

Too often companies put together matches that look great on paper but are fraught with management and structural problems that end up turning them into busts. Sometimes, of course, acquisitions can be great. Clorox's (NYSE:CLX) purchase of Burt's Bees has been very beneficial, giving the buyer a strong new product line positioned outside of its traditional areas. But such experiences are the exception, not the rule.

Here are some lessons companies should think about before embarking on an M&A strategy.

Beware the Clash of Cultures

The first mistake acquiring companies make is underestimating the problems that unalike company cultures can inflict on a merger. Staid Bank of America's (NYSE:BAC) acquisition of white-shoe Merrill Lynch and its thundering herd of highly paid brokers highlights just how important culture is in determining the success or failure of a merger. Dozens of senior Merrill bankers, like George H. Young III, have left since the merger to join competitors like Lazard Ltd (NYSE:LAZ). Many left because they didn't want to give up the fast pace of Wall Street, where money is king, to work in a commercial banking culture with Southern characteristics.

The difficulties over bonuses and the integration of the two companies are well known. Ken Lewis, Bank of America's chief executive officer, has lost his chairmanship and has had to spend more time testifying on Capitol Hill than building his business. His time would have been better used repairing Bank of America's balance sheet and regaining consumer trust.

Bank of America's acquisition of Merrill Lynch stands out as a testament to a central problem in many failed mergers. The company cultures of the two firms simply aren't compatible. Many at Merrill resented being acquired because they felt superior to anyone at a commercial bank. Companies going the M&A route need to make very sure that the two organizations mesh well.

Culture Matters Less with Products Than with Services

E-learning provider Blackboard's (NASDAQ:BBBB) takeover of WebCT in 2006 provides a counterpoint to the story of Bank of America and Merrill Lynch. In this case the two companies were culturally closely aligned within their industry. Moreover, the merger didn't cause defections. At Merrill many of the deals were based on relationships; Blackboard's clients were purchasing products and were locked into multiyear contracts, making it easy for the transition to occur without the loss of many sales. Some of WebCT's salespeople left, but Blackboard was able to ensure ongoing client relationships without having to struggle to keep those clients.

Our research found that mergers have a higher chance of succeeding for companies that sell products than for those that provide services based heavily on personal connections. In the former cases, the merging of the two businesses and any changes in human capital don't do nearly as much harm. Also, the people at WebCT didn't tend to feel their business was far superior to Blackboard, as many at Merrill felt about Bank of America.

Lost Time Is Never Found Again

Coca-Cola's (NYSE:KO) recent failed bid to take control of Huiyuan Juice received a lot of coverage in the press because it was a high-profile example of an international brand trying to buy an important Chinese company and getting rejected. I wrote about this for Forbes.com. Less was said about whether Coke was taking the right approach to growth within China's juice market in the first place. Should the company have been focusing on organic growth instead?

In the time Coke spent trying to acquire Huiyuan, in negotiating the deal, in conducting due diligence and in waiting for regulatory approval, it lost time it could have spent building up its own juice labels within the market. Juice is one of the fastest-growing beverage segments in China, as consumers look for healthier alternatives to cola drinks.

Coke obviously knows how to develop new products and market them effectively. It did so with the Chinese launch of Coke Zero. Rather than pursuing Huiyuan and wasting valuable time, Coke should have been aggressively expanding the presence of its Minute Maid brand. Instead it left the door open for PepsiCo's (NYSE:PEP) Tropicana, which has come on strong in the last year. Pursuing a merger or acquisition too often wastes too many resources all allocated the wrong way. Companies lose time they will never recover.

Merge Unequals, Not Equals

Gillette found its Duracell brand losing market share to domestic battery makers in China because many Chinese consumers didn't want to spend much on batteries. The company realized it would have trouble penetrating the market with the premium Duracell brand, and it couldn't take Duracell down market without eroding the brand's long-term viability.

With two complementary brands, the company was able to improve its operating margins and distribution. The acquisition was an overall win. The brands were complementary and created no friction between them. Had the companies been equal in size, though, the merger would not have gone as smoothly. Being much larger than Nanfu, Duracell was easily able to implement the organizational changes it had to make.

Valuations are so low right now that companies can buy at bargain basement prices--but that doesn't mean they can necessarily buy long-term value. The difficulty of merging corporate cultures cannot be overstated, and some targets in some locations can't be acquired anyway.

Businesses should definitely use the downturn as an opportunity to invest in differentiating themselves from the competition, but often organic growth is the better way to go. Don't rush into the problems that Ken Lewis and Bank of America have had.